Carry Forward and Set off of Business Losses other than Speculation Loss (Section 72)

(1) Introduction to Section-72

Section 72, which deals with the carry forward and set off of business losses. This section allows taxpayers to carry forward their business losses and set them off against future profits, reducing their taxable income.

Carry Forward of Business Losses

Under Section 72, a taxpayer can carry forward business losses for up to eight consecutive assessment years immediately following the year in which the loss was incurred. This means that if a taxpayer incurs a business loss in a particular year, they can offset that loss against their business profits for the next eight years.

However, it is important to note that the carry forward of losses is allowed only if the taxpayer continues to carry on the same business. If there is a change in the ownership or nature of the business, the losses cannot be carried forward.

Set Off of Business Losses

Section 72 also provides for the set off of business losses against other income of the taxpayer. This means that if a taxpayer has incurred a business loss but has income from other sources, they can set off the losses against that income, reducing their overall taxable income.

The set off can be done in two ways:

• Set off against any other income in the same assessment year: A taxpayer can set off their business losses against any other income they have earned in the same assessment year. For example, if a taxpayer has a business loss of Rs. 1,00,000 and has earned Rs. 2,00,000 from other sources, they can set off the business loss against the other income and pay tax only on the remaining Rs. 1,00,000.
• Set off against any other income in the following years: If a taxpayer is unable to set off their business losses in the same assessment year, they can carry forward the losses and set them off against any other income they earn in the following years, within the eight-year limit. This provision provides flexibility to taxpayers who may not have sufficient income in a particular year to set off their losses.

Conditions for Carry Forward and Set Off

There are certain conditions that taxpayers must meet in order to avail of the carry forward and set off of business losses under Section 72:

• The taxpayer must file their income tax returns within the due date specified by the Income Tax Act.
• The taxpayer must maintain proper books of accounts and get them audited if required.
• The taxpayer must continue to carry on the same business in order to carry forward the losses.
• The business must be the same for which the losses were incurred.
• The taxpayer must continue to be engaged in the same business in the year in which the loss is set off.
• The loss can only be set off against profits and gains of the same business or profession.
• The loss can be carried forward for a maximum of eight years.
• If the taxpayer discontinues the business, the losses can only be carried forward for four years.

Change in the Constitution of the Business:

In case there is a change in the constitution of the business, such as a merger or amalgamation, and the business continues, the accumulated losses can be carried forward and set off by the successor entity under certain conditions.

(2) Business Losses can be adjusted only against Business Income

In the context of the Income Tax Act, business losses can typically be adjusted only against business income. This principle is in line with the specific provisions of the Income Tax Act, including Section 72.

When a taxpayer incurs a business loss in a particular financial year, they are generally allowed to carry forward that loss and set it off against the profits and gains of the same business or profession in future assessment years. This means that you can use the loss from one year to reduce the taxable income from the same business or profession in subsequent years.

It's essential to note that losses from one head of income, such as "Profits and Gains of Business or Profession," cannot usually be set off against income from other heads, such as "Salaries" or "Capital Gains," unless specific provisions of the Income Tax Act allow for such set-offs, as explained in my previous responses.

(3) Business in respect of which a Loss is incurred may or may not be Continued

In the context of the Income Tax Act, when a loss is incurred in a business, the continuation or discontinuation of that business is a factor that affects how the losses can be adjusted for tax purposes. Here's how it works:

Continuation of Business:

If a taxpayer incurs a loss in a business or profession and continues to operate that same business in the subsequent financial years, they can carry forward and set off the losses against the profits and gains of the same business in those future years.

Discontinuation of Business:

If the taxpayer discontinues the business in which the loss was incurred, the treatment of the losses changes. In such cases, the losses can still be carried forward, but they can only be set off against the profits and gains of the same business if the business is re-established within a specified period, typically within four years from the year in which the loss was incurred. If the business is not re-established within this period, the losses may become ineligible for set-off.

So, whether or not the business is continued has implications for how the losses can be adjusted for tax purposes. If the business is continued, losses can be set off against future profits from the same business. If the business is discontinued, there is a time limit within which the business must be re-established for the losses to remain eligible for set-off against future business income.

(4) Losses can be Set Off only by the Assessee who has incurred Loss

Where any person carrying on any business or profession has been succeeded in such capacity by another person otherwise than by inheritance, nothing in this Chapter (relating to set off and carry forward of loss) shall entitle any person other than the person incurring the loss to have it carried forward and set off against his income. In other words, the brought forward business losses can be set off only by the same assessee. The assessee, who has suffered the loss and in whose hands the loss has been assessed, is the person who can carry forward the loss and set off the same against his business income of the subsequent year.

The following are the exceptions:

(a) Inheritance:

Where a business carried on by one person, is acquired by another person through inheritance.

For Example:

X is carrying on a business and there are losses to the extent of Rs.5,00,000 which can be carried forward and set off against the income of the subsequent years. X dies and his son S inherits his business. The losses incurred by X can be set off by his son S against the income from a business activity carried on by S. However, such loss can be carried forward by the son for the balance number of years for which the father could have carried forward the loss. However, the unabsorbed depreciation cannot be carried forward by the legal heir as inheritance is not covered under section 32(2).

(b) Amalgamation:

Business losses and unabsorbed depreciation of an amalgamating company can be set off against the income of the amalgamated company if the amalgamation is within the meaning of section 72A/72AA of the Income-tax Act. If the amalgamation is not of the nature specified in section 72A/72AA, the business loss and unabsorbed depreciation of the amalgamating company cannot be carried forward by the amalgamated company. Similarly, business losses and unabsorbed depreciation of an amalgamating co-operative bank can be set off against the income of successor cooperative bank, i.e., the amalgamated co-operative bank, if the amalgamation is within the meaning of section 72AB.

(c) Succession of Proprietary Concern or a Firm by a Company:

Where there has been reorganization of business whereby a proprietary concern or a Firm is succeeded by a company and certain conditions mentioned in section 47(xiii) or (xiv) arc fulfilled, the accumulated business loss and the unabsorbed depreciation of the predecessor proprietary concern/firm shall be deemed to be the loss or allowance for depreciation of the successor company for the previous year in which business reorganisation was effected and carry forward provisions shall be applicable to the successor company.

(d) Succession of a Private Company or Unlisted Public Company by a Limited Liability Partnership:

Where there has been reorganization of business whereby a private company or unlisted public company is succeeded by a limited liability partnership and certain conditions mentioned in section 47(xiiib) are fulfilled, the accumulated business loss and unabsorbed depreciation of the predecessor company for the previous year shall be deemed to be loss or allowance for depreciation of the LLP for the previous year in which business reorganization was effected and carry forward provision shall be applicable to successor LLP.

(e) Demerger:

Loss of the demerged company can be carried forward by the resulting company subject to fulfilment of certain conditions which the Central Government may for this purpose notify, to ensure that the demerger is for genuine business purposes. Similarly, certain losses of the demerged co-operative bank can be carried forward by the resulting co-operative bank in certain cases.

(5) Period of Carry Forward:

Each year’s loss is a separate loss and no loss shall be carried forward for more than eight assessment years immediately succeeding the assessment year for which the loss was first computed. Therefore, a loss of previous year 2021-22, i.e., assessment year 2022-23 can be carried forward till assessment year 2030-31.

Besides the above, the following can also be carried forward indefinitely although these are not business losses as per Income-tax law:

(i)         unabsorbed depreciation;

(ii)        unabsorbed capital expenditure on scientific research;

(iii)       unabsorbed expenditure on family planning.

(6) Order of Set Off:

Unabsorbed depreciation, unabsorbed capital expenditure on scientific research and unabsorbed expenditure on family planning are not parts of business losses and they can also be carried forward. However, as per section 72(2), the business loss should be set off before setting off unabsorbed depreciation. etc. Such carried forward business loss will be set off against business head only after the current year’s depreciation, current capital expenditure on scientific research and expenditure on family planning have been claimed. Therefore, the order of set off will be as under:

(i)         current year depreciation [Section 32(1)];

(ii)        current year capital expenditure on scientific research and current year expenditure on family planning to the extent allowed;

(iii)       brought forward business or profession losses [Section 72(1)];

(iv)       unabsorbed depreciation [Section 32(2)j;

(v)        unabsorbed capital expenditure on scientific research [Section 35(4)];

(vi)       unabsorbed expenditure on family planning [Section 36(1)(ix)].

(7) Return of Loss:

The return of loss must have been furnished before due date prescribed under section 139(1), otherwise the loss cannot be carried forward.

Here's how it works:

Carrying Forward Losses:

If a taxpayer incurs losses in a particular financial year and wishes to carry forward those losses to offset against income in future years, they must file their tax return for that financial year on or before the due date specified in Section 139(1). This is typically July 31st of the assessment year.

Consequence of Missed Due Date: